Reynolds to pay $27.4 billion for Lorillard

Reynolds American RAI agreed to pay $27.4 billion to acquire Lorillard LO, in a merger that will combine the second and third-largest U.S. tobacco companies as the industry struggles with a chronic decline in sales.

Under the terms of the deal, which has been approved by both board of directors, Reynolds American agreed to buy Lorillard in a cash-and-stock deal currently valued at $68.88. Shares of Lorillard, which has a market capitalization of about $24 billion, closed at just over $67 on Monday.

The deal terms also include a divestiture, aimed at appeasing regulators. Reynolds American agreed to sell off several assets to the U.K.’s Imperial Tobacco Plc ITYBY. Those brands include KOOL, Salem, Winston, Maverick and blu eCigs. Imperial is acquiring those assets for $7.1 billion in cash, and Reynolds American said it expects to receive net cash proceeds of about $4.4 billion after taxes.

Those assets are meant to make Imperial a stronger player in the U.S., where market leader Altria MO commands roughly half of the traditional cigarette market. If Reynolds and Lorillard were to combine as they currently exist, only two strong tobacco producers would exist. But with the asset sales, Reynolds claims Imperial’s U.S. operations will “more than triple its share of the U.S. cigarette market,” and thus “elevate it to the status of a major U.S. competitor for the first time.”

Some analysts, like Wells Fargo’s Bonnie Herzog, have touted the benefits of the deal. Herzog says the Reynolds-Lorillard combination creates a stronger second player to go head-to-head with Altria, as well as create a more rational environment for price actions. But with only two “powerful” cigarette companies, Herzog also says the industry may see stricter contracts and smaller players could be squeezed.

The assets being acquired by Imperial include Lorillard’s manufacturing and research and development facilities in Greensboro, N.C., and about 2,900 employees, including a national sales force.

Meanwhile, British American Tobacco Plc BTI will keep its 42% ownership of Reynolds through an investment of about $4.7 billion, based on Reynolds’ closing price of $60.16 as of July 2, the same price used to consider the stock portion of the Lorillard acquisition.

The combined Reynolds-Lorillard will be led by Susan Cameron and maintain its headquarters in Winston-Salem, N.C.

Cameron, the first woman to run a major tobacco company, rejoined the company earlier this year after previously serving as president and chief executive from 2004 to 2011. Lorillard Chief Executive and Chairman Murray Kessler will join Reynolds’ board after the deal closes.